Principles of Working Capital:
Working Capital: There are two concepts of working capital- gross and net.
Gross working capital: It refers to the firm’s investment in current assets. Current assets are the assets
that can be converted into cash within an accounting year (or operating cycle) and include: cash, shortterm securities, debtors, (accounts receivable or book debts), bills receivable and stock (inventory).
The gross working capital focuses attention on two aspects of current assets management: (a) How to
optimize investment in current assets? (b)How should current assets be financed?
Net working capital: It refers to the difference between current assets and current liabilities.
Operating Cycle: It is the time duration required to convert sales, after conversion of resources into
inventories, into cash. The operating cycle of a manufacturing company involves three phases like:
1. Acquiring of resources: Such as acquiring of material, labor, power and fuel etc.
2. Manufacture of the product: It includes conversion of raw material into work-in-process into
finished goods.
3. Sale of the product: It may be either for cash or on credit. Credit sales create account receivable
for collection.
The length of the operating cycle of a manufacturing firm is the sum of:
(i)
Inventory conversion period (ICP): It is the total time needed to producing and selling the
product. Typically it includes:
(a) Raw material conversion period (RMCP)
(b) Work-in-process conversion period (WIPCP)
(c) Finished goods conversion period (FGCP)
(ii)
Debtors conversion period
The total of inventory conversion period and debtors’ conversion period is referred to as
gross operating cycle.
Payables deferral period (PDP) if the length of time the firm is able to defer payments on
various resource purchase. The difference between (gross) operating cycle and payables
deferral period is net operating cycle.
Gross Operating cycle =
(GOC)
conversion period +
(ICP)
Debtors conversion period
(DCP)
ICP = Raw material conversion period (RMC)+ work-in-process conversion period
(WIPCP)+finished goods conversion period (FGCP)
Similar calculations can be made for other inventories, debtors, and creditors.
1. RMCP = Raw material inventory (RMI)  [(Raw material consumption (RMC)/360]
=
RMI  360
RMC
2. WIPCP = work-in-process inventory(WIPI) 
=
Costofproduction(COP )  360
RMC
WIPI  360
COP
3. Finished goods conversion period (FGCP) = Finished goods inventory (FGI)  [Cost of goods sold
(COGS)  360]
FGI  360
CGS
4. Debtors conversion period (DCP) = Debtors (D)  [Credit sales at cost (CRSALES)  360]
D  360
=
CRSALES
Creditpurchases (CRPUR)
5. Payables deferral period (PDP) = Creditors (CRS)  [
360
CRS  360
=
CRPUR
=
NET OPERATING CYCLE = Gross Operating cycle – Payables deferral period
(NOC)
= GOC
- PDP
Problem: Consider the following statement of costs and sales for a firm given in table 1
Items
1. Purchase of RM
2. Opening RM inventory
3.
4.
5.
6.
7.
8.
9.
10.
11.
12.
13.
14.
15.
16.
Closing RM inventory
RM consumed(1+2-3)
Direct labor
Depreciation
Other mfg. expenses
Total costs (4+5+6+7)
Opening WIPI
Closing WIPI
Cost of production (8+9-10)
Opening FG inventory
Closing FG inventory
Cost of goods sold (11+12-13)
Selling, admin. And general exp.
Cost of sales (14+15)
2012
4,653
523
827
4,349
368
82
553
5,352
185
325
5,212
317
526
5,003
304
5,307
Required: Find the Net Operating Cycle as of year 2012 for the given firm.
Permanent and Variable Working Capital: (See page 814)
Dangers of excessive working capital: See page 815
Determinants of Working Capital:
1.
2.
3.
4.
5.
6.
7.
Nature of the Business
Sales and Demand Conditions
Technology and Manufacturing Policy
Credit Policy
Availability of Credit
Operating Efficiency
Price Level Changes